Member Sign In

You are being directed to ZacksTrade, a division of LBMZ Securities and licensed broker-dealer. ZacksTrade and Zacks.com are separate companies. The web link between the two companies is not a solicitation or offer to invest in a particular security or type of security. ZacksTrade does not endorse or adopt any particular investment strategy, any analyst opinion/rating/report or any approach to evaluating indiv idual securities.

If you wish to go to ZacksTrade, click OK. If you do not, click Cancel.

July 11: Are Investors Headed for Disappointment?

What did we see in Wednesday’s Fed minutes and in the Bernanke speech afterwards that seem to have calmed the markets down? The dollar and treasury yields have eased a bit as a result and stocks are heading back towards new all-time highs.

There was nothing that was substantively new, but both the minutes as well as Bernanke went to great lengths to dial back expectations for the course of monetary policy - as a way to stem the rising tide of long-term interest rates. And as we have been seeing repeatedly over the last couple of weeks, the stock market seems to be liking what it is hearing from the Fed. The bond market still remains skeptical, though it appears to have a paused a bit as well.

The Fed minutes tried to emphasize that the decisions to start ‘tapering’ and hike Fed Funds rates were distinct and unrelated. In putting this gem of an insight into the minutes, the Fed was trying to make the point that ‘tapering’ didn’t mean tightening. From the Fed’s perspective, if they buy $65 billion bonds a month post ‘tapering’ instead of the current $85 billion, they are still easing.

The bond market and most of the other ‘normal’ people think otherwise. From the bond-market’s perspective, ‘tapering’ amounted to the first shot in a gradual monetary policy normalization in which the Fed would first end the QE program and then start eying the Fed Funds rate. As a result, the bond market started rates higher, pushing it almost 100 basis points higher in less than two months.

The Fed appears to have been unnerved by the bond market’s reaction and is trying its best to control it. Bernanke even went to the extent in his speech yesterday that the Fed could hold off on touching the Fed Funds rate for a very long time even after the unemployment rate fell to 6.5%, which was the Fed’s prior target. We will see how all of this unfolds in the coming days and weeks. But at least for now, the stock market doesn’t seem to be overly concerned by the jump in treasury yields and has no problem reclaiming its May peak despite substantially higher interest rates.

The stock market’s response could be justified on grounds of improved economic growth and corporate earnings outlook. While consensus GDP growth estimates for 2013 Q2 are barely close +1%, the same for the second half of the year and next year show a lot more momentum.

The same picture emerges from consensus earnings estimates for the second half of the year. While total earnings growth is expected to be barely in the positive territory in Q2, they are expected jump by more than +5% in Q3 and more than +11% in Q4. For full year 2014, total earnings are expected to be up an additional +11.5%. We haven’t heard much positive guidance for the coming quarters from the companies that have already reported Q2 results like Oracle ((ORCL - Free Report) ), FedEx ((FDX - Free Report) ), Accenture ((ACN - Free Report) ) and others. Financial firms typically don't provide forward guidance, but it will be interesting to see how J.P. Morgan ((JPM - Free Report) ) and Wells Fargo ((WFC - Free Report) ) dealt with the sudden spike in interest rates in Q2. Both these banking leaders report before the open tomorrow.

But if recent history is any guide, then we should brace ourselves for another round of predominantly negative guidance this earnings season as well, causing estimates for Q3 and Q4 to start coming down. This trend has played out repeatedly over the last few quarters, with investors essentially shrugging negative estimate revisions each time. Market bulls believe that we will get a repeat performance this time around as well, with the stock market not losing even beat as estimates for the second half of the year and next year come down. May be the bulls are right and nothing will happen.

But forgive me for being a bit skeptical of these soothing voices. My sense is that the stock market is disregarding the jump in treasury yields because it is looking for strong earnings growth in the coming quarters. But earnings growth can’t miraculously appear in the back half of the year or next year. With margins already at historical highs and revenue growth hard to come by in a growth-constrained world, double-digit earnings growth may firmly be in the rearview mirror. Investors bidding up stocks in hopes of strong earnings growth in the coming quarters are heading towards a disappointment.

Resources

Client Support

Follow Us

Zacks Research is Reported On:

Yahoo

MSN

Marketwatch

Nasdaq

Forbes

Investors.com

Morningstar

Zacks Investment Research is an A+ Rated BBB Accredited Business.

Copyright 2016 Zacks Investment Research

At the center of everything we do is a strong commitment to independent research and sharing its profitable discoveries with investors. This dedication to giving investors a trading advantage led to the creation of our proven Zacks Rank stock-rating system. Since 1988 it has nearly tripled the S&P 500 with an average gain of +26% per year. These returns cover a period from 1988-2015 and were examined and attested by Baker Tilly Virchow Krause, LLP, an independent accounting firm.

Visit performance for information about the performance numbers displayed above.